Challenges Facing DMA Support in Asia

Archive for the ‘Predictions’ Category

The Case for China

I’m not bullish on China, neither as a place to do business nor as a place to invest. China has for over two Beach House Blackhead decades been “the next big thing,” and even though there have been minor gains I have always maintained that the society is not built on a foundation of trust which we tend to take for granted in the West. I believe her long-term prospects are not bad, albeit extremely over-valued at the moment.

This morning two articles landed in my Inbox from two very different sources. The first is your standard “I’m Bullish on China” article, from Finance Asia blog:

http://www.financeasia.com/News/245945,hong-kong-really-is-the-worlds-freest-economy.aspx

The Heritage Foundation once again ranked Hong Kong as the world’s freest economy this year, and in our web poll last week readers agreed with that assessment.

For the 17th year in a row, Hong Kong topped the class thanks to its small government, low taxes and light regulation. Barriers to entry are low, property rights are secure and contracts are respected. In short, the conservative think-tank reckons Hong Kong is a Tea Party paradise. On paper, at least.

The article makes it clear that Hong Kong is not China per se, but the sentiment is there. The race to open the financial floodgates between the two economies has peaked over the last two years, and for most foreign investors getting exposure to Hong Kong equals getting exposure to the mainland economy.

Now, Blind Freddy can see that the existence of trust in Hong Kong (a British colony until recently) does not equate to the existence of trust in mainland China. But what if there was a different way of looking at this problem of trust? Maybe the fact that China is doing things completely different to the US is a strong point?

Dilbert artist Scott Adams gives us this perspective:

http://dilbert.com/blog/entry/freedom_of_data/

China’s system, as I have written before, reminds me more of a corporate structure, or a meritocracy. In a corporation, you’re generally free to disagree with higher ups if you do it with data, and in a professional manner. Usually you need to go through proper channels, but dissent is generally allowed, and sometimes actively encouraged. If you’re a jerk about your disagreement with your superiors, or you don’t have persuasive data to back up position, you could get fired. But that’s a stupidity issue, not a freedom issue.

China’s leadership is packed with engineers and lawyers by training. I imagine that like any corporation, they appreciate the value of information when presented in a professional manner, and through proper channels. Unlike elected politicians, managers in a meritocracy are free to change position as new or better data emerges. The advantage of having only one political party is that everyone is on the same team. And if effectiveness is the goal, which apparently it is in China, I assume that new data is generally welcome.

Wild assumptions aside, Adams does have a point, and perhaps the best argument I have seen so far in favor of the Chinese System ™.

While Freedom of Speech is important on an individual and human rights level, it would have to be one of the most destructive forces around when it comes to actually getting things done. China may have the right idea, somewhat akin to Japan’s kaizen of the 1970s and 80s (which led to improvements in the toilet seat that still blow my mind to this day).

Adams’ readers are knee-jerk-quick to point out the flaws in his argument, but, at the risk of coming off pro-China, I think what he says definitely has merit. As I mentioned, one of the greatest periods of innovation (well, improving on things they copied from the West) in Japan came about under similar conditions as in China today.

But for long-term prospects, I’m still shorting China. Anyone who has spent time in the mainland has no doubt experienced first-hand the fact that Chinese are all out for themselves, short-term profits over long-term sustainability. This is deeply ingrained in their culture, and isn’t going to change any time soon.

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Supporting Algorithmic Trading in Asia

A while back I was asked the question “what do you see in the short-to-medium term so far as algos in Asia are concerned?” While Asia with its quirks and idiosyncrasies has meant that the standard set of algorithms (VWAP, TWAP, participation, plus an aggressive (ie will actively cross the spread) and a passive offering) have had to be all but re-coded for the various Asian markets, I felt that the average algorithm user (in many cases brokers trading on behalf of clients) would demand a rationalization of the algos available. At the time the company I was working for had just developed a fancy new algo and were having all the usual troubles that come with deploying it in Asia without any testing whatsoever. Other companies were promoting the fact that they offered over 150 different algorithms across several dozen brokers.

My prediction was based on the 80-20 rule (and let’s face it, the lion’s share of the volume from funds trading Asia via algorithms do so via VWAP), and has been somewhat correct, with one major broker that I know of decommissioning two algorithms, probably due to the cost-ineffectiveness of maintaining rarely-used algorithms in the region. However today I see on Asia Etrading that the march continues, with Instinet adding one more algorithm to their suite.

This news reminded me of some of the challenges of supporting algorithms in Asia which I have noticed over the last few years.

Local Development Team
For starters, you need to have a team locally who knows the intricacies of the various Asian markets, and is available for support during Asian hours. No longer is it acceptable to raise issues to the US support team, and get back to the client the next day. If you’re not prepared to commit to a local development team then you’re probably not going to be taken seriously by clients.

One unavoidable consequence of this is that upgrades branch entirely from their US/Europe upgrade path. And when you are already thin on resources in the area you can find you have an ever-increasing gap between client demands and the implemented reality. Especially for clients trading Asian markets from the US or Europe, all they want is for their algorithms to function the same, seamlessly across regions. If you’re involved in the support of these clients be prepared to explain to the folks in Sales and to the client directly. I recommend a proactive approach, but I understand that this isn’t always feasible.

A Few Good Men
Related to the above point, sourcing support staff can also be an issue. You can’t just fly someone over from the US, unfamiliar with local markets, in order to oversee a server-side upgrade of an algo. This also affects emergency replacement of staff when people leave – for other roles you can often easily just substitute someone in from another region temporarily to cover until a replacement is found (expect a post from me talking about this in more detail shortly).

Infrastructure in Every Region
As algorithms tend to be implemented as a separate service running on a server, it is possible to co-locate just the algorithm server in certain cases. Ironically the firms that can support this infrastructure best are large, established operators, whereas it is the smaller firms that could really benefit from being able to separate the infrastructure. For comparison, the “smaller” firm I worked at previously chose to have the majority of the infrastructure in Hong Kong. TSE-bound orders were sent out from Hong Kong “post-processing” to a broker in Japan. Needless to say, latency was a significant issue.

All-in-all the issues for supporting algorithms in Asia are similar to the issues for supporting other electronic trading support functions. However I find that the issues tend to be more pronounced, and the severity of mistakes can be much higher. I guess on the flip side, for those companies who are prepared to commit to providing and supporting algorithms properly, localizing and fine-tuning them as appropriate, it can definitely give the impression that the company has a strong commitment to the region.